Zell's fancy turns away from real estate

Chicago financier Sam Zell is seeking new opportunities in a range of industries, including pharmaceuticals, home products and transportation. Photo: Todd Winters

Sam Zell would rather talk about ironing boards than office buildings these days.

Sam Zell would rather talk about ironing boards than office buildings these days.

The billionaire investor who championed real estate investment trusts (REITs) in the 1990s has seen shares in his three Chicago-based REITs trail the broader REIT market over the past five years. Renowned as a "vulture investor" for his skill at spotting undervalued assets, Mr. Zell bet on the wrong real estate sectors and hasn't been able to parlay a bigger-is-better theory into superior returns for his REITs.

Mr. Zell, clad in gray pullover and faded blue jeans, bristles at the suggestion that his real estate strategy has flopped, dropping in a few expletives for emphasis. He says two of his three REITs have outperformed rivals since they were launched in the early 1990s.

"I'll put my track record against anybody," he snaps in an interview in his office overlooking the Chicago River.

His smile returns when the subject shifts to other investments. Surrounded by artwork, photos and other artifacts from four decades of investing, he sounds ready for a new phase in a career marked by distinct scene changes  from his buyouts of distressed industrial companies in the 1980s to his leading role in bringing REITs into the investing mainstream a decade later.

"At the moment, I think the opportunities for acquisitions and the opportunities for consolidation are much more interesting outside real estate," says the investor, whose familiar bald head and bearded countenance have graced the pages of business publications for decades.

Mr. Zell's investing fancy has turned from office buildings and apartments to river barges, pharmaceuticals and Chicago-based Home Products International Inc., a company that makes clothes hangers and ironing boards.

An investment group including Mr. Zell's Chicago-based Equity Group Investments LLC last year took over Home Products, which had $233 million in sales in 2003. He talks of using the company as an acquisition vehicle to create a consumer products powerhouse with the heft to negotiate on equal terms with big retail chains like Wal-Mart Stores Inc. and Target Corp.

"You've got to create power opposite power to make (the relationship) work," Mr. Zell says.

Another of Mr. Zell's investments, cough medicine maker Adams Laboratories Inc., plans to go public in May, he says. Equity Group owns about one-third of New Jersey-based Adams, according to Mr. Zell.

Mr. Zell brightens even more as he talks about American Commercial Lines Inc., the largest river barge operator in the country, which recently exited Chapter 11. He bought bonds in the Indiana-based company prior to its filing for bankruptcy protection, emerging as a large equity holder when it reorganized, with about a 40% stake.

After cashing in many of those investments, he returned to real estate, where he'd started his investing career in the early 1960s as a University of Michigan law student, buying apartment buildings. Scooping up bargains in the wake of the early-1990s real estate collapse, he assembled portfolios of office buildings, apartment houses and mobile-home communities.

He was among the first real estate investors to offer shares in his REITs to the public. Since 1994, when Morgan Stanley created a benchmark performance index for REIT shares, Mr. Zell's Equity Residential LLC apartment REIT has returned 312% to investors, and his Equity LifeStyle Properties LLC mobile-home REIT 261%. The index's return for the same period was 262%.

"These companies are doing fine," he says. "They are worth measurably more than the price they're trading for and I think they have fulfilled their objectives to shareholders."

LOWER PERFORMERS

Mr. Zell's Equity Office Properties Trust, the nation's largest owner of office properties, has returned 67% since it went public in 1997, trailing the index's 118% return for the same time frame. Uncharacteristically, Mr. Zell paid top dollar for a Northern California office portfolio at the height of the dot.com boom, a move that dragged down returns when the region's economy tanked several years ago. Equity Office shares also suffered from investor skepticism of Mr. Zell's theory that larger REITs will produce higher returns through economies of scale.

"I would much rather have a value creator than somebody who goes for economies of scale," says Jerry Ehlinger, portfolio manager in the Chicago office of Rreef Funds, a real estate investment advisory firm.

In the last five years, returns (share price appreciation plus dividends) have lagged at all of Mr. Zell's Chicago-based REITs. While the Morgan Stanley REIT Index climbed 156% during the period, Equity LifeStyle returned 146%, Equity Residential 125% and Equity Office just 79%.

BLAMES THE CYCLE

A big reason for the poor showing is Mr. Zell's failure to invest in the two hottest real estate sectors of recent years, retail and industrial. REITs in those sectors posted average returns of 218% and 164%, respectively, in the last five years, while office and apartment markets suffered.

Mr. Zell is unapologetic, blaming the real estate cycle, not his strategy, for the weak performance. He's confident his REITs will beat the market over time.

Nobody has more riding on the REITs than Mr. Zell, who serves as chairman of all three. His combined holdings in Equity Office, Equity Residential and Equity LifeStyle are worth $900 million, about 41% of the $2.2-billion net worth Forbes magazine estimates for Mr. Zell.

So far, there's no sign the REITs' diminished performance has dimmed Mr. Zell's star power on Wall Street. His presence as an investor in Desarrolladora Homex SA helped the Mexican homebuilder pull off an initial public offering in the U.S. last year. Its shares are up 62% since its IPO.